Chindia at a Crossroads

India must look to capital investment, China to consumers, to fulfill their global potential, says JM Morgan Stanley's executive director

by Chetan Ahya

The economic ascendancy of India and China is naturally one of the most widely discussed trends in today's globalized world. The countries' advantages are formidable: huge surpluses in working-age populations; cost competitiveness; efficiencies in manufacturing and services; and huge markets increasingly integral to the business strategies of multinational companies, all make them structural drivers for global productivity and disinflation.

The two economies will be the dominant growth stories for the next 30 years. By 2015, India's gross domestic product will reach the $2 trillion mark while China's will surpass $6 trillion, driven by the powerful combination of favorable demographics, structural reforms, and globalization. There is little doubt that the importance of the two countries is only likely to rise.

But the virtuous path to growth is seldom smooth. At this moment, when the world is in awe of these two developing nations, both India and China are actually at a critical juncture. If they stumble, their ambitions of being global powers and influencers could be derailed. Both need to dramatically reassess their growth models and initiate the difficult policy reforms they have avoided so far, to keep on the high-speed growth track.

Ironically, each of their respective greatest challenges has been the other's greatest success. India's growth has been consumption-led, and China's has been investment-led. Now it's time they learn from each other. India requires an aggressive investment and export thrust while cooling consumption; China needs to slow its investment and export drive in favor of consumption.

RURAL EFFORTS.

More importantly, while both have been the great success stories of globalization, their track record on human development has been poor. According to the UN's 2005 Human Development Report, at lower levels of income and economic growth Vietnam has performed better than China in improving the child mortality rate. Similarly, Bangladesh has achieved better results than India in this respect. In this context, the challenge is bigger for India than China. China's rural human development is higher than India's human development across its entire population.

Not surprisingly, both India and China have been initiating efforts in the rural areas where the majority of their populations live and which have long been neglected. India has announced an increase in the education budget, a new rural-unemployment guarantee scheme, and a health renewal plan. China has announced a massive rural infrastructure investment plan, a removal of agricultural tax, an increase in the rural education budget, and a revamping of the rural health-care system.

So far, China's record in terms of budget and pace of implementation has been better. The dragon appears more determined in terms of its action plan compared with the elephant. For instance, over the next the five years, India intends to spend about $38 billion on countrywide road building, while China plans to spend $148 billion just on rural roads.

CAPITAL EXPENDITURES.

Indeed, demand in India for infrastructure services has grown exponentially, but is frustrated by a weak response from the supply side -- especially from government, which then restricts the private-sector investments. Already India's private and state investments as a percentage of GDP are way lower than China's. That's an inherent problem with India's growth model. The recent sharp fall in global interest rates had meant a significant rise in foreign portfolio investment and also debt in emerging markets, particularly India. But a large part of this foreign liquidity has been used to boost consumption instead of investments.

In other words, the government is not aggressive enough in using the opportunity of these low-cost funds pouring into India for building roads, airports, and power plants, or for empowering the poor with better education and health. Instead it is using it for distributing freebies to the masses (the bulk of government's expenditure goes into subsidies, wages, and interest costs), the efficacy of which is anyway questionable.